BNY Strategist Geoff Yu notes that EUR flows have flipped from a pre-conflict ‘hedge the Dollar’ theme to a net underheld position. With Eurozone stagflation concerns contrasting Norway’s positive terms-of-trade shock, he argues that EUR is now more sensitive to any improvement in sentiment, while Norwegian Krone (NOK) strength could stall if energy prices peak and Norges Bank resumes FX purchases.

Euro underheld as NOK remains crowded

"Assuming the ceasefire holds over the next two weeks, the “easiest” FX flows to realize would be mean reversion of the “extreme” moves since the beginning of the conflict. On the outflow side, emerging market currencies facing balance of payments stress and developed market currencies exposed to stagflation were hit hardest. At the other end, energy- and commodity-linked currencies with clear policy space were bid."

"The EUR and NOK currently occupy both ends of the spectrum and perfectly encapsulate this view: the Eurozone is seen as struggling with stagflation as energy costs bite, while Norway will see a strongly positive terms-of-trade shock, and Norges Bank has largely pre-committed to a hike – the only developed central bank in Europe to do so."

"The EUR remains the most affected by the unwind of the ‘hedge the dollar’ theme exhibited before the conflict. The process is now fully complete, to the extent that the EUR is now net underheld on an aggregate basis."

"From a domestic asset allocation perspective, given the year-to-date performance of U.S. equities remains manageable, we can only surmise that forward buying of EUR for hedging purposes has been taken off in size – which is striking given rate expectations have moved in a direction which would normally necessitate the opposite behavior. Regardless, now that the EUR is net underheld, the bar for reversing flows is now much lower."

"In contrast, NOK’s gains may halt for now if energy prices peak. Even if energy prices remain elevated, we believe receipts will be large enough to meet government financing requirements such that the Norges Bank may shift toward FX purchases again, representing an additional layer of resistance against positive NOK flows, and NOK holdings remain by far the strongest among European currencies."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)